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Google’s black box of ad pricing makes it impossible to understand if partners are getting a fair share.

When Google (NASDAQ: GOOG) offered a “direct to consumer” domain parking option last month, many cheered. “Finally, we can cut out the middleman!” they exclaimed. But others worried about potential downsides. Specifically, domain owners realized that they have little bargaining power with Google compared to parking companies that aggregate significant traffic.

Google’s Domain Parking Agreements

To better understand how Google can squeeze its partners, it’s important to understand the deals Google has in place with partners such as DomainSponsor, NameMedia, and Sedo.

These contracts are confidential. But thanks to NameMedia’s (since aborted) attempt to go public, we can peek inside a Google Adsense contract. Here are some things to note:

1. There are three types of feeds: Adsense for Content, Adsense for Domains, and Adsense for Search. Adsense for Search is the search feed from Google. This ad feed can be called anytime someone types a search query into a box on a parked page. It is also called if someone clicks on a link on a parked page labeled “Related Searches”. I’m still unclear as to the difference in ads shown on Content and Domains, but these ads can be shown on the landing page of a parked page or on additional pages. If you have a one-click lander with Google, all of the ads on the home page are from the content or domains feed.

2. Parking companies get a higher revenue share if they send more traffic. The NameMedia agreement has three tiers, which presumably pays a higher percentage of revenue to NameMedia if it sends a greater amount of revenue to Google. (Note that it is based on revenue amount, not traffic amount.)

You may be thinking “Great! The parking companies have negotiated certain revenue share percentages with Google that cannot be changed. We’re locked in.” Well, sort of.

First, this is one of the main concerns with going direct to Google parking and cutting out the middleman. You won’t have a guaranteed percentage, so Google can squeeze you whenever it needs to boost earnings.

Second, just because the percentage payout to the parking companies can’t change during the contract period doesn’t mean the actual amount paid out can’t change, as I’ll explain below.

An Elusive Revenue Share

Let’s consider how percentages mean very little in these agreements, and why Google may have an incentive to collect less per click on the parking pages even if it means Google in turn earns less per click.

In order to understand this you need to consider Google Adwords, the program that supplies ads to Google Adsense. Google Adwords Advertisers generally bid a maximum amount per keyword. But they also set a budget. For example, I may say “Bid $1 per click for these keywords, but I don’t want to spend more than $1,000 a day”.

At first it seems Google will want clicks on all pages — whether part of the Google.com or Adsense sites — to be close to the maximum price. But Google’s margin is much higher on Google.com because it doesn’t have to pay partners. So it has an incentive to have more of the ad budget spent on Google.com than at partners.

For example, assume an advertiser has a $1,000 budget and it is maxed out every day. Google could send half of the traffic from Google.com and half from the AdSense network at $1 a click. Here’s how much Google will make, assuming the partner has a 75% revenue share:

Now, what if Google discounts the clicks on Adsense 50%, arguing they aren’t worth as much as those on Google.com? The advertiser still wants to spend $1,000 a day. So the rest of the traffic goes to Google.

As you can see, Google needs to merely shift the budget toward its own properties to earn more money. The advertiser gets more clicks, too. Google can pay the same percentage to parking companies but pay less per click, while at the same time making more money for itself.

Note that this is against Google’s stated goal of offering the best deal to the advertiser. If both Google.com and Adsense convert at the same rate, the second option gives the advertiser more conversions. But a third option of all Adsense traffic would be the best for the advertiser, but the worst for Google: it would only earn $250.

Is Google squeezing us already?

A lot of people cite Google’s Traffic Acquisition Costs (TAC) metric to show that advertisers are getting less. But the metric says very little about partner payouts. Here’s a graph of TAC updated in Q3 2008:

Above: a graphic that means a lot to investors but little to partners.

The blue line represents Google’s expense for traffic as a percentage of advertising revenue. The green bars primarily represent the amount paid out to traffic partners.

Many people point to this falling percentage — 37.2% in Q1’05 and 27.9% in Q3’08 — to show that Google is paying its partners less. But this number means very little, because we don’t know what percentage of traffic is generated on Google.com versus Adsense sites. In fact, you can see that Google is actually paying more to partners now than before. But again, without knowing the actual traffic amount we know very little.

Indeed, revenue on Google.com and other Google properties increased 34% in Q3’08 compared to one year earlier. Revenue on Adsense increased only 15%. But this is revenue, not traffic, so we still don’t have much insight into if Google is paying more or less to its partners. It’s a black box, and only Google knows what’s inside.

A Ticking Time Bomb
There’s one other thing that could drop parking partners’ shares of revenue overnight faster than a gradual squeeze.

In the NameMedia agreement (and I’m told the same goes for other agreements) Google retains the right to eliminate the search ad feed. Search ads generally pay more than content ads. So overnight, domain owners could see a massive drop in revenue. Google is required to provide a replacement feed to NameMedia if it removes the search feed. If the replacement feed doesn’t perform within x% of the search feed, NameMedia has one recourse: cancel its agreement with Google.

Canceling the agreement doesn’t seem like a good alternative.

Should we bite the hand that feeds us?

For all of the complaining about Google, keep in mind that without Google the domain industry would be a shadow of what it currently is. Google’s ad network has propelled the parking industry to where it is today. Should we not complain about Google’s market power? Should we be thankful for what it has given us and not question its motives?

It’s a tough question. We know our parking revenue is dropping, but is it because Google is squeezing us? Because it’s a black box, partners’ relationships with Google are based on trust. And Google has been losing a lot of trust. Notifying parking partners of a drastic change in competitive strategy just a day or two in advance doesn’t build trust.

It’s good to question authority. Which is why we shouldn’t all run out and thank goodness that Google is cutting out the middleman.

Almost all of us were surprised today when Google (NASDAQ: GOOG) said it was opening up its Adsense for Domains program. It used to offer domain advertising relationships only to people with massive traffic, then it shut down the application process completely, and now it’s offering it up to anyone with a domain. From talking to a couple sources, it sounds like Google partners were notified of this last week.

To be sure, what Google is offering Adsense account owners is a far cry from the advertising feeds it offers DomainSponsor, Sedo, and Fabulous. But this is a still a major development.

Some of the initial reaction was jubilation. People think that going direct to Google means cutting out the middleman.

I doubt it. Even if there’s some increase in the near term, it allows Google to lower the payouts in the long term. (And a short term increase is doubtful; my tests with the service shows almost all ads are from the content ad feed and quality landing templates are lacking.)

Consider what domain parking companies bring to the picture. First, they bring traffic aggregation. This gives them bargaining power when negotiating payouts with Google. Second, they bring technology that improves earnings and minimizes fraud. There’s a reason DomainSponsor has mathematicians on staff. They’re tweaking everything to maximize earnings. Parking companies have to get the fraud part right because they often times pay earnings to customers before they get their final report from Google.

These benefits cannot be understated.

Now consider what you bring to the table: A little bit of traffic and no technology. If everyone went direct to Google, there would be just as much traffic but no bargaining power and no technology. Whereas parking companies have long term payout contracts with Google, individuals get their payout percentage changed at will.

Soon I’ll be writing about “the Google squeeze” in which Google is able to dial back the revenue share with many of its publishers. It has found a way to do it with parking companies even though they have fixed percentage payouts. By going direct to domain owners, you can expect an even more drastic pullback on payouts.

Is Google doing this to gain bargaining power with the parking companies? Perhaps.

There’s one other angle to consider here. Perhaps Google doesn’t have grand plans. Perhaps it is targeting people that wouldn’t normally qualify to use a domain parking service. Joe Adsense Publisher who has a few spare domains. Google can make money from him. With revenue under pressure, Google is looking for anything to keep the machine going.

[See update at bottom with latest information.] In a surprising move, Google (NASDAQ: GOOG) is now offering Adsense publishers the opportunity to park their domains directly with Google, rather than using a second-tier provider such as DomainSponsor or Sedo. Domain Name News caught on to this official Google post earlier today.

I’m personally shocked at this move, given the retreat Google seems to have been making in the domain channel. Google previously only wanted to work with people generating over 750,000 visits a month, and then later shut down Adsense for Domains applications all together. For now, it seem that Google is not going to cut the long tail out of domain parking. It also isn’t distancing itself further from the industry. It is doing just the opposite.

But before you get excited about going direct to Google, I suspect your earnings will go down by doing so. Domain parking aggregators such as DomainSponsor negotiate high revenue shares with Google, something you won’t be able to do. Additionally, templates are limited to Google’s standard Adsense for Domains landers, which probably won’t convert as well as advanced landers from traditional domain parking companies. Also, you can’t just change your nameservers or forward your domains; you must create an A record and CNAME for each domain.

I suspect Google may be trying to put heat on parking companies by opening up its system to anyone with an Adsense account. At first this program will attract people who only have a handful of domains and can’t get accepted by most domain parking companies, but I’m sure Google will expand it from there.

I logged into my account moments ago to see how it works. The screenshot below shows the option of Adsense for Domains on the Ad Setup tab:

You submit your domains for consideration, and they are “pending” until Google approves them. I suspect it does a general scan for trademarks.

You can edit the colors of your landing pages and suggest keywords that should be used to trigger ads. However, you can’t edit the layout, ad pictures, or customize text.

UPDATED: I have set up my first domain on the service. It was painful setting it up because you have to set up A records and CNAME for each domain. Furthermore, it just uses Google’s simple one-click template. The front page ads are all from the content feed instead of the search feed. It appears that if you click on related links it still shows content ads. The only way it shows search ads is if you actually type in a search term. Let me know if you see otherwise. Also, I’ve heard that a beta tester used the system and received poor results. That doesn’t surprise me. But Google may have some tricks up its sleeves…it always does. Here’s what my landing page looks like: